Today marks an important milestone for AI. Remember where you were when you read this.

A computer taught itself to play chess with no prior knowledge of the game other than the rules. It then beat the current world champion computer chess program.

There is a story in the Guardian here.

I remember when a computer program first beat Gary Kasparov. Back then the program was tuned by chess and AI gurus and used brute force searches to evaluate millions of moves. Yes, it won – but the match up seemed unfair on the human.

This time the computer knew only the rules of the game. It taught itself to play by playing lots of games against different versions of itself. It uses a neural network, which is analogous to the human brain. It has lots of very simple processing elements (like neurons) connected in a complex network. Like the human brain, neural nets are good at pattern recognition. This one evaluates far fewer moves than the brute force approach because it learned to recognise the most promising possible moves and evaluate those in greater depth.

This is really impressive, because it is a general purpose AI that doesn’t need human knowledge about a problem. At the moment it is limited to very well structured problems – games. But it is an important step on they way to genuine thinking (and learning) machines.

This sort of generalised learning has enormous commercial (or social or military) potential if combined with systems dynamics and agent-based approaches (where complex real world systems, such as markets, are modelled as large numbers of autonomous interacting units representing people or companies, say). For example, a business could use this approach to develop the optimal pricing strategy, including responses to competitor actions.

I believe that, sooner than we expect, business strategy (like driving) will be considered too important and risky to be left to humans.

I am interested in talking to businesses about exploring these applications.

]]>In defence of the bank levyhttp://www.firstcity.com.au/in-defence-of-the-bank-levy-2/
Thu, 18 May 2017 15:20:11 +0000http://www.firstcity.com.au/?p=551Read More]]>Sometimes governments do the right things, even if for the wrong reasons

When an Australian financial institution is Too Big Too Fail there is the implication that the federal government will step in to bail them out or facilitate a shotgun wedding (say, by indemnifying the acquiring bank) should they be at risk of collapse. This is the very definition of moral hazard for the government.

This is a benefit enjoyed by the TBTF institutions for which they have hitherto not had to pay. It is an example of market failure that creates an uneven playing field. For this reason I have privately argued for a liability-based Moral Hazard Levy for many years. The government’s recently announced levy is a step in the right direction, towards applying a price signal on what has previously been a free benefit.

The government’s recently announced levy is a step in the right direction, towards applying a price signal on what has previously been a free benefit.

The full detail of the levy is not yet known. We know only that a 0.06% levy will apply to as yet unspecified liabilities of the four major banks and Macquarie and that the levy is expected to raise c.$1.5 billion per year. This article suggests a robust and equitable mechanism for a Moral Hazard Levy.

Three key questions need to be answered. To what should the levy apply? To whom should the levy apply? What is the appropriate rate?

To what should the levy apply?

The government is right to base the levy on liabilities. These are, after all, what will have to be made good in the event of collapse. But which liabilities? Some portion of the assets on the balance sheet will be realised, surely? Then there is the buffer provided by the excess of assets over liabilities (AKA Shareholders Funds). In the best case the government might realise the net assets. In the worst case, the assets might vaporise and the government would have to cover total liabilities. To keep it simple and objective, I suggest the levy should apply to the halfway point between those two extremes. The formula is:

Levy Base = (Total Liabilities – Shareholders Funds) / 2

To whom should the levy apply?

The government has explicitly identified Macquarie plus the big four banks. But what about insurance companies? I suggest the levy should be phased in from a lower threshold of “clearly not TBTF” to a higher threshold of definitely TBTF.

Guidance for the lower threshold might be provided by Australia’s largest financial institution collapse, HIH Insurance Group. HIH was not bailed out. According to the last annual report prior to the collapse it had $7.1 billion total liabilities and net assets of $0.9 billion. So its levy base would have been $3.1 billion – but that was sixteen years ago. I suggest the levy should begin phasing in from a base of $5 billion.

Guidance for the upper threshold might be provided by Macquarie, the smallest of the five to be nominated by the government to pay the levy. According to its latest annual report it has $165.6 billion total liabilities and net assets of $17.3 billion. So its levy base would be $74.2 billion. I suggest the levy should apply fully from a base of $50 billion, coincidentally 10 times the lower threshold.

The table below shows Australia’s largest financial institutions, ranked by total liabilities.

This approach would see five more financial institution paying at least a portion of the levy: Bank of Queensland, IAG, QBE, Bendigo Bank, Suncorp and AMP. Of these only AMP would be subject to the full levy.

What is the appropriate rate?

The bank has set the levy at 0.06%. In an opinion piece in the AFR, Christopher Joye argued that increased credit rating of the banks due to the government’s implicit guarantee is worth 0.17% in reduced funding costs.

At the other end of the spectrum are the fees that the banks themselves charge their customers for providing guarantees. For a small business the fee is around 1.50%, when cash or property is provided as security. Large corporates might get the fee down to 0.50%.

Under my suggested approach, to generate $1.5 billion in pre-tax levies requires a rate of 0.09% of the levy base – as shown in the following table.

At that rate the big four are paying between $300 million and $360 million each. Or between 2.7% and 4.3% of pre-tax profits. The hardest hit under this regime is AMP, who would pay 8.0% of underlying profit – reflecting its relatively poor profitability. Return on equity would be down by around 0.4% for all the big four and by 0.5% for AMP. This would hardly seem to merit the shrill responses that have been heard from some quarters – especially as those same complainants often express their desire for level playing fields.

What if the rate was set at 0.17%? The government take would rise to $2.9 billion and the big four return on equity would be down by around 0.8% – still hardly fatal.

One more thing

I have yet to see any commentary to date on the impact of the levy on inequality – but this seems to be a good example of a “Robin Hood” tax. It is likely to contribute to a reduction inequality rather than exacerbate it. But that’s a topic for another article.

]]>Putting out fire with gasolinehttp://www.firstcity.com.au/putting-out-fire-with-gasoline/
Thu, 04 May 2017 06:09:54 +0000http://www.firstcity.com.au/?p=546Read More]]>…or why assistance to home buyers (first or otherwise) is a bad idea.

In a very civil facebook debate (they are rare, but possible) about housing affordability discussion turned to incentives for new home owners. “Surely this is the scalpel-like policy that we need?”, said my interlocutor. I argued this was a really dumb policy. The idea crops up so often, including apparently in the forthcoming federal budget, that it’s worth going into print about it.

On first principals, policies which add to demand are not the optimal way to improve affordability. Almost by definition, policies should seek to increase housing supply or reduce demand, not add to it. That’s another article.

Secondly, by virtue of the banking system and the auction process, attempts to assist targeted groups may have a disproportionate impact on prices and not actually solve the targets’ problem.

For the sake of the argument, I’ll divide the market into “battlers” and “others” – and assume the others have access to materially more money than the battlers. If you give battlers an extra $20k, say, (whether it be by way of direct assistance, subsidised stamp duty, access to their super fund or otherwise) it is likely that they would add this to their deposit; borrow an extra $180k (assuming a 90% LVR); and prices will rise by $200k.

“But”, comes the response, “not everyone will receive the benefit. So prices won’t go up by anything near $200K.” This reflects a fundamental misunderstanding of the auction process.

If we were talking about a consumer good, where the actions of buyers generally have no short term impact on price, then handouts will help battlers obtain the goods. But the situation is different in markets where the majority of houses are sold by auction. This is because by definition, the auction process only tells us how much the second highest bidder was prepared to pay.

“…the auction process only tells us how much the secondhighest bidder was prepared to pay.”

Provided the others are less constrained than the battlers who receive the handout, battlers could, in theory, raise the overall market price by $200k by going to auctions and bidding an extra $200k only to be topped by their wealthier rivals. Having missed out at the first auction they go to, the battlers go to more auctions and the process repeats until the price at every auction has been pushed up by $200k.

That way the number of property prices lifted is much greater than the number of battlers receiving the hand out and the amount of the increase can be exactly the amount of extra firepower (the hand out geared up by the increased borrowing power) given to the battler. And the battlers still haven’t bought homes!!

]]>The gig economy 2.0?http://www.firstcity.com.au/the-gig-economy-2-0/
Sun, 09 Apr 2017 22:11:25 +0000http://www.firstcity.com.au/?p=507Read More]]>The rise of businesses like Uber, Airtasker and numerous vertical market specialists has been heralded as the death of employment as we know it. Anybody on a wage is worried that this signals a race to the bottom. Will all workers in future be part of the “precariat” – dependent on short term contracts or assignments?

Maybe, not so much.

Firstly, the contractor model is under legal attack in many jurisdictions as being a means of avoiding tax, labour laws or various compliance obligations.

Secondly, there is a new wave of service platforms that realise that employing staff is better when it comes to training and controlling service levels and the customer experience. Who woulda thought that it might not be easy to get a contractor to sing from the company hymn book?

To the customer, companies like Luxe (valet parking), Eden (tech support), and Sprig (food delivery) look like the now familiar on demand businesses that we have come to know and love. But the service is actually delivered by paid employees.

None of the newer generation of businesses has achieved the explosive growth of the now “classic” model. But, just maybe, its worth trading off growth for a sustainable, ethical and legal business?

The UN and OECD have undertaken much research on what makes people happy and have identified seven main factors found to support happiness: caring, freedom, generosity, honesty, health, income and good governance. Notice, only one of these is directly economically related. It turns out that social foundations are more important for happiness. That’s great news – because happiness is not dependent on infinite growth on our finite planet.

The fifth annual World Happiness Report has just been published. It finds that Norway, Denmark, Iceland, Switzerland and Finland are the happiest countries in the word. Note to Australia:

Norway moves to the top of the ranking despite weaker oil prices. It is sometimes said that Norway achieves and maintains its high happiness not because of its oil wealth, but in spite of it. By choosing to produce its oil slowly, and investing the proceeds for the future rather than spending them in the present, Norway has insulated itself from the boom and bust cycle of many other resource-rich economies. To do this successfully requires high levels of mutual trust, shared purpose, generosity and good governance, all factors that help to keep Norway and other top countries where they are in the happiness rankings.

New Zealand and Australia rank 8th and 9th respectively – out of 155 countries. (Before my Kiwi friends start emailing, the difference between the two is within the margin of error.)

Other broad findings:

People in China are no happier than 25 years ago – notwithstanding a significant increase in wealth

Much of Africa is struggling

Happiness is falling in the USA

When was the last time you heard an Australian politician talking about increasing happiness?

]]>A free kick to retailers and a drag on the economyhttp://www.firstcity.com.au/a-free-kick-to-retailers-and-a-drag-on-the-economy/
Sun, 26 Feb 2017 22:12:54 +0000http://www.firstcity.com.au/?p=511Read More]]>It doesn’t take an economist to work out that the reduction in Sunday penalty rates will cause an overall reduction in total wages paid even after allowing for increased employment. This will, in turn, most likely result in a net reduction in economic activity.

Much has been written about the recent decision by the Fair Work Commission to reduce Sunday penalty rates from 200% to 150% (a reduction of 25% of the Sunday rate). Some decry the impact on earnings of existing Sunday workers and the flow on effect to the economy. Others assert that more retailers will open on Sunday, thereby offsetting the negative impacts. It seems pretty easy to mathematically prove which side is most likely to be right.

Firstly, we need to ascertain what proportion of retailers are already open on Sundays. These are the ones that get a free kick of 25% of Sunday wages. They include all the large retailers in the major categories: supermarkets, department stores, clothing, electrical, hardware. The level of concentration (the proportion represented by the top 5 players) varies significantly between categories, from 100% (department stores) to 17% (clothing). For food and liquor it is 85%. Overlay on this the concentration of retailing into shopping centres, all of which seem to be open on Sundays. (Admittedly this is a major metro perspective.) For argument’s sake, let’s say retailers representing 90% of employees already trade on Sundays.

Then we need to estimate how many new positions will be created on Sunday due to the lower wages. For the sake of the argument, let’s assume for the time being that half of those retailers that previously didn’t trade on Sunday, decide to trade on Sunday. So the Sunday workforce increases from 90% to 95%.

Without much maths at all it’s obvious that total wages paid to employees will decline. The 5.6% increase in the workforce doesn’t go anywhere near offsetting the 25% reduction in wages. Even if 100% of retailers opened (an 11.1% increase in the workforce) total wages paid would decline significantly.

In fact an increase in the size of the workforce of 33% is required to offset a 25% reduction in wages. That’s just not conceivable in the Australian retail environment. It seems highly likely therefore that total wages paid by retailers will decline.

Which is better for the economy, $1 increased profit of a retailer or $1 in the hand of an employee? Of the $1 in the hands of the retailer, some may be returned to consumers by way of lower prices, some may be returned to shareholders via dividends or share buybacks, some may be appropriated by senior management pursuant to profit based incentive schemes, some may be invested in growing the business. The $1 in the hands of the employee will be saved or spent. It seems likely that the bulk of the $1 will be spent and fairly quickly at that, so taking a $1 out of the hands of an employee is likely to lead to a greater reduction in economic activity than the increase in activity caused by putting $1 into the hands of a retailer.

In summary, the reduction in Sunday penalty rates seems likely to cause an overall reduction in total wages paid, even after allowing for increased employment. This will, in turn, most likely result in a net reduction in economic activity.

Disclosure: I do have a horse in this race. My daughter is a university student and part-time retail employee.

#retailing #fairworkcommission #penaltyrates #economics

]]>The “secret” of long life, health and happinesshttp://www.firstcity.com.au/the-secret-of-long-life-health-and-happiness/
Tue, 29 Nov 2016 22:14:00 +0000http://www.firstcity.com.au/?p=513Read More]]>As a financial analyst I am somewhat (that is, very) biased towards empiricism. I like empirical studies that prove or disprove hypotheses. Each one gives me a little bit of comfort as it removes an element of uncertainty from my universe.

The Harvard Study of Adult Development is thought to be the longest study of adult life that’s ever been done. It started in 1938 and has tracked the lives of 724 men. The study has had four directors and continues to this day, now including partners and children. The study cohort includes Harvard graduates and men from the wrong side of the tracks.

As it turns out wealth, fame and careers are things that men think are important – but which are poor predictors of longevity, health and happiness.

So what is the secret? In the words of Robert Waldinger, the current Director:

The clearest message that we get from this 75-year study is this: Good relationships keep us happier and healthier. Period.

Waldinger identifies three big lessons:

Social connections are really good for us – and loneliness kills.

It’s the quality of close relationships that matters – not just the number of friends or whether you’re in a committed relationship (and a corollary, conflict is unhealthy).

If health and happiness are considered desirable, it makes no sense to sacrifice relationships for careers, fame or money. The observation of many that apparently do make such sacrifices begs the questions: Why do people sacrifice relationships and happiness for things that will not make them happy? Is it through ignorance, a sense of duty or some other factors?

You can see Robert Waldinger present the study findings in a TED talk here.

]]>Business as a force for good – or having your cake and eating it toohttp://www.firstcity.com.au/business-as-a-force-for-good-or-having-your-cake-and-eating-it-too/
Mon, 07 Nov 2016 22:14:37 +0000http://www.firstcity.com.au/?p=515Read More]]>Are we at an inflection point in the way business is conducted? That is the premise of the Business Philosophy’s 21st Century Inflection Point.

Sometimes it’s hard to imagine that the commercial world could be much different to the way it is now. Sure, maybe it could do with a little tweaking around the edges – but the foundation of “enlightened self-interest” is a golden rule – almost Platonic in its purity, right? Bryan Welch points out that our idea of free enterprise developed less than 300 years ago, in the Industrial Revolution. There are plenty of other “certainties” that have come and gone – divine rule of kings, the geocentric planetary system, etc.

The inflection point that Welch talks about is the concept of business as a force for good – a large and growing movement of consumers, businesses and investors who want to “harness the power of markets to create positive change”. This means expanding the concept of “return” to include non-financial measures. It also means the ends don’t justify the means – the journey is actually more important than the destination.

This movement is spontaneous and bottom up. In my view it reflects the best aspects of the human spirit. Given a choice we naturally prefer to do good rather than evil. It doesn’t need to be legislated – we just need the opportunity.

The B Corp movement is an exciting development in this direction. Businesses voluntarily undergo an assessment which addresses impacts on customers, employees, community and environment. Those scoring above a certain threshold may designate themselves as certified B Corps. This provides a means for consumers and businesses to identify other businesses that are trying to make a positive change.

As the number of B Corps grows a network effect is kicking in. It is becoming increasingly easy for B Corps to buy from and sell to other B Corps – and for consumers to direct an increasing share of their expenditure to B Corps. This will eventually create an environment where businesses will be unable to succeed without generating adequate social returns.

Imagine an economy where a broad based concept of doing good supplants financial metrics. I believe it will happen – and when it does, we’ll look back at the financial age in the same way that we regard other unfortunate periods in human history.

]]>The importance of balancehttp://www.firstcity.com.au/the-importance-of-balance/
Tue, 16 Aug 2016 22:15:16 +0000http://www.firstcity.com.au/?p=517Read More]]>We recently had the opportunity to work with quite an impressive business. It was founded by two brothers. They have established their own manufacturing operation in china. Presently most of the sales are to Australia, but global sales are starting to take off.

What we learnt was inspirational, as these two guys in their early 30s had achieved something greater than business success. Balance!

Success in business, staff that are happy and well paid, plenty time spent with family, fun with their hobbies, travel and constant innovation in all areas of life. They have mastered business and life at a level few get to experience.

What was even more interesting was that these blokes knew when to sell equity in their business. This is something that we, as corporate advisors, don’t see often.

These men had an exceptional mentor in their father, but not as you might imagine. Dad is also an independent business operator. He works 24/7 in his business and has little time for anything else. The two brothers watched their dad and thought, before starting their first business at an exceptionally early age, they were going to do business differently. They set out to learn from top mentors how to manage a business, and how to work smarter rather than harder.

We asked, “Why do you want to sell down just when the business is poised for global expansion?” Their answer was, “We are not driven by the need to accumulate money at the cost of everything else. We are driven by innovation and building a great business and we want to partner with someone that can take the business to a level that we can’t. Also, we are family men, we have all the money we need, we have a life outside of our business, a balance that is uncommon to most entrepreneurs.”

Like poker, you’ve got to know, “when to hold ’em and when to fold ‘em”.

We will be interviewing these two great entrepreneurs in a video for our web site.

Many hard working Australians are so committed to their businesses that they can’t break free and experience a life outside business. Also when it comes to selling all or part of their equity, we often hear, “I’ll look at it next year after after….” Sadly, next year often doesn’t come until either owner or business are passed their used by date.